Knowing your ‘future self’ can help you make better financial decisions

ShlomoBenartzi

DavidFaro

We’d like to ask you a question about your current self and future self. The question will involve a bunch of circles, but bear with us: Knowing which circles you identify with can help you determine if you should be spending more or less money now to live the life you want—and the life you can afford.

Let’s start with your current self. Think about the qualities that make you the person you are now. Consider your personality, temperament, beliefs and values.

Second, consider the person you expect to be in a few years. How similar or different do you think you’ll be?

Choose which of the seven diagrams in the accompanying table best reflects your expectation.

The Wall Street Journal

These circles measure a psychological concept called self-continuity. The term describes the tendency to identify with and connect to our future self. If your circles are mostly separate, then you tend to think of your future self as if he or she is a distinct person. You have low self-continuity. If you chose circles that are mostly overlapping, then you’re exhibiting a high level of self-continuity—you tend to feel a greater connection to your future self.

A classic theory

For this discussion, it’s important to understand that the higher the level of self-continuity, the more likely you are to make better financial decisions about the future. Self-continuity varies between individuals, but it can be manipulated—that is, people can be nudged into feeling more connected to the person they will be someday by, for example, engaging in mental exercises in which they visualize themselves at certain points in the future. So those who have low self-continuity can do something about it.

To understand why high self-continuity can lead to better spending decisions, it helps to know a classic economic theory called consumption smoothing.

The theory assumes that because people desire a relatively stable path of consumption, they should balance out spending and saving over the course of their lives to maintain the most consistent standard of living they can. That means if you’re anticipating less income in the future, you should probably cut back now and save more, so you won’t be forced to dramatically reduce your standard of living when you’re older. But if you’re anticipating more income, then you might want to spend more, even if it means incurring some debt, so you aren’t abstaining from things today that could improve your life.

Many consumers don’t engage in consumption smoothing, however. As is often the case, the economic theory doesn’t fit with their psychological reality.

Why the disconnect?

When asked to explain why some people might not adjust their spending down or up in anticipation of income changes, economists typically blame factors such as myopia, the difficulty of taking on debt, or worries that extra income won’t actually materialize. But new research by Anja Schanbacher, David Faro and Simona Botti of the London Business School suggests that self-continuity also can play an important role in determining whether people engage in consumption smoothing. By measuring self-continuity levels, the scientists determined that the more people feel similar and connected to their future selves—their circles are mostly or totally overlapping—the more likely they are to adjust current spending based on expectations of future income.

This new work builds on previous research showing that self-continuity can influence many of our everyday choices. People with low levels of self-continuity, for example, might indulge in too many desserts since they aren’t really thinking about the future health consequences.

Low self-continuity also can impact finances. Interventions that enhance a person’s sense of self-continuity—such as photo-shopping a picture to make someone look older—can lead to significantly higher savings rates because people invest more in their future when they feel more connected to it.

In the new study, the London Business School researchers found that when they took steps to heighten self-continuity in their study subjects, consumption smoothing increased. If the subjects were expecting a decrease in future income, they cut current spending. And if they were expecting an increase, they tended to boost what they spent. It didn’t matter if they were considering a massage or a concert ticket—their willingness to spend was strongly influenced by how vividly they could imagine the person they would be in the future.

The scientists also discovered a quirk that can lead some people to act too responsibly: People tend to feel less connected to their future self when their future self has more money. The result is that consumers are naturally less likely to adjust spending upward than downward when anticipating changes in future income.

Drawbacks of prudence

This asymmetric response might seem like good news, at least for our bank accounts. While low self-continuity is often linked to impatience and overindulgence, this new research shows that, in certain instances, it might actually lead us to underspend. And if we don’t spend money we don’t yet have, we are less likely to accumulate credit-card debt and take out costly loans.

However, it’s also worth considering the potential drawbacks of such prudence. Most workers will have an income peak late in life, toward the end of their careers. Unless they are willing to spend money based on their future expected earnings, they’ll forgo all sorts of pleasures that they can probably afford to enjoy. Maybe it’s a nice bottle of wine, or a skiing vacation with the family—we shouldn’t pass up purchases that will make us happy just because of a psychological quirk that shapes our consumption decisions.

What’s more, some experiences are best enjoyed when we’re younger and in better health. This doesn’t mean we should go out and buy a sports car or vacation house; if our expected income boost doesn’t arrive, we’ll be stuck with a mountain of debt we can’t afford.

But it does suggest that if you are expecting to earn significantly more in the future and you chose circles that are far apart, you may want to consider indulging in small luxuries you’ve been putting off. Just as there are psychological tendencies that lead us to act irresponsibly—eat too much, not save for retirement—there are psychological biases that lead us to postpone pleasures we probably should be enjoying.

Knowing your level of self-continuity is useful because it can help you make decisions that strike the right balance between the needs of your present and future selves. Feeling connected to your future self can help you avoid overspending today without putting off affordable pleasures. After all, we never know how many days our future self has left.

Dr. Shlomo Benartzi, a frequent contributor to the Journal Reports, is a professor and co-head of the behavioral decision-making group at UCLA Anderson School of Management and author of “The Smarter Screen” about online behavior. Dr. David Faro is an associate professor of marketing at the London Business School. Email them at reports@wsj.com.

Mortgage Rates

Powered by

This advertisement is provided by Bankrate, which compiles rate data from more than 4,800 financial institutions. Bankrate is paid by financial institutions whenever users click on display advertisements or on rate table listings enhanced with features like logos, navigation links, and toll free numbers. Dow Jones receives a share of these revenues when users click on a paid placement.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.